Internal Revenue Code Section 412(i) covers defined benefit plans that are funded solely by annuity contracts and/or insurance contracts, including retirement income endowment contracts. A defined benefit plan is a retirement plan sponsored by an employer, such as a pension plan, in which a retired employee receives a specific monetary disbursement based on salary history and years of service, or both. A 412(i) plan is a defined benefit plan wherein the funding (annual contribution) is calculated under the rules of Code Section 412(i). It is also referred to as a fully-insured plan.
It is desirable to qualify a pension under Section 412(i) because qualifying plans are exempt from the funding requirements of Code Section 412. This includes exemptions from the minimum funding standard account, the full funding limitation, quarterly contributions, reasonable actuarial assumption interpretations, and the Schedule B Enrolled Actuary certification that is otherwise required to be filed with the Forms 5500 for the plan.
Generally, the requirements for qualification of a plan as a 412(i) plan are:
(1) The plan must be funded exclusively with annuity contracts or a combination of life insurance contracts and annuity contracts.
(2) The contracts must provide for level annual payments to begin when an individual becomes a plan participant and extending not later than the retirement date under the plan.
(3) The plan benefit must be provided entirely by the contracts and guaranteed by an insurance carrier to the extent premiums have been paid.
(4) Premiums payable for the plan year and all prior plan years under such contracts must have been paid.
(5) No rights under the contracts may be subject to a security interest during the plan year.
(6) No policy loans may be outstanding at any time during the plan year.
Since the plan benefits must be guaranteed by the insurance company that issues the life insurance contracts and the annuity contracts, the plan's actuarial assumptions may be based on the guaranteed values in the contracts. This means that the plan must fund for benefits based on the guaranteed annuity conversion factors in the contracts and must assume the pre-retirement interest assumption that is guaranteed in the life insurance contracts and/or the annuity contracts.
Traditional (prior art) 412(i) plans are constructed with traditional whole life or fixed rate annuity policies to fund benefits. Only whole life insurance has been used in a 412(i) plan because State insurance laws require that a guaranteed dividend be earned on such policies. Consequently, in the prior art, it was presumed that the policy's guaranty constituted the only way for the insurance company to satisfy the section 412(i) requirement that benefits be guaranteed. Generally, although such contracts have a guaranteed rate of return (usually 4.5% per annum or less), the potential upside investment performance is very limited because of conservative investments made by insurance companies. Limited upside performance has impaired consumer demand for whole life contracts, in general; and this has also impaired demand for 412(i) plans.
It would be advantageous to use a variable life insurance policy and/or a variable annuity policy in a 412(i) plan to take advantage of better tax treatment for the employer sponsoring the plan, while at the same time being able to reap higher returns on higher risk investment vehicles. However, the conventional belief is that one cannot use a variable life insurance policy and/or a variable annuity policy to fund a 412(i) defined benefit plan.